About the Relationship Between Stablecoins and Security Tokens

Crypto news last week were dominated by the headlines of J.P Morgan announcing the intentions to launch its own stablecoin dubbled “JPM Coin”. My initial reaction to the news were mixed. On one hand, the JPM Coin represents a strong validation for the stablecoin market and will certainly pave the way for new banks to join this trend. However, we can’t be oblivious to the fact that commercial-bank-backed stablecoins are likely to contribute to the fragmentation of the space and basically be a temporary solution until central banks decide to issue their own stablecoin(more about that in a future post). The launch of the JPM Coin made me reflect about a thesis I’ve been exploring lately about the relationship between stablecoins and security tokens. With stablecoins quickly consolidating as an important building block of the crypto-ecosystem, it is important to explore how they will influence the next generation of digital securities.

Stablecoins, not utility tokens, is the rightful predecessor to digital securities. From the functional standpoint, stablecoins address one of the fundamental blocks of any securities structure: payments. In fact, stablecoins a new form of value transfer we haven’t seen before: stable-programmable payments. Until now, security tokens have relied on off-chain, fiat-based payment methods for any form of dividend distribution. Leveraging stable-programmable payments in security tokens improves the efficiency of many traditional securities scenarios open the door to new forms of securities we’ve never seen before.

Stablecoins and Security Tokens

The relationship between stablecoins and security tokens goes way beyond enabling the payment foundation for digital securities. Conceptually, I like to think about the link between stablecoins and security tokens as a bidirectional one: stablecoins enable new forms of security tokens which in turn can be combined to build new forms of stablecoins in a relationship only limited by the underlying programming model. Which, in traditional financial markets, is very challenging to create new fiat currencies backed by specific assets, that limitation doesn’t necessarily exist in crypto-land. New forms of non-collateralized or crypto-collateralized stablecoins can emerge from security tokens in a very intriguing cycle.

The financial vehicles that can be created by programmable models that combine security tokens and stablecoins are nothing short of fascinating but we need to start somewhere. Pragmatically speaking, the combination of digital securities and stablecoins can unlock several key scenarios in crypto markets in the near future.

Dividend Distributions

Imagine a debt security token that distributes dividends to token holders every hour or a collateralized position that distributes an interest payment every day? While the programmability of smart contracts enables dividend distribution models that are impossible in traditional markets, we need a stable unit of account to encapsulate the dividend payment. Implementing dividend distribution in security token smart using fiat vehicles is extremely cumbersome and simply takes too long. Stablecoins provides a crypto-native, programmatically efficient mechanism to enable dividend distributions as a first-class citizen of security tokens.

Let’s take a scenario of a tokenized bond in which the token holders will receive dividends regularly during the day. In this scenario, the bond issuer can maintain a wallet with a deposit of MakerDAO’s Dai that will be used by the bond smart contract to distribute dividend to token holders. The programmability of stablecoins like Dai enable dividend payments to be dynamically trigger based on all sort of conditions related to the market behavior of the bond or the token holders.

Instant Settlements

Many large securities transactions take days to settle. We all know that blockchains can bring down settlement times down to minutes but what if part of the transaction relies on fiat vehicles? Imagine an investor wiring $2M from a bank account to take a position on a specific crypto-security? Our investor can certainly convert his $2M to crypto but that process also takes some effort. Leveraging stablecoins as a payment mechanism can drastically reduce settlement times and streamline the corresponding processes in crypto-securities.

Collateralized Debt Positions

Imagine a scenario in which an investor is allowed to borrow against his holdings of specific crypto-securities. This scenario is by no means new in financial markets with infamous examples such as collateralized debt obligations(CDOs) that resemble this dynamic. The crypto-space has its own version of the CDO known as collateralized debt positions(CDP) pioneered by protocols like MaketDAO. Conceptually, a CDP allows a crypto investor to lock a pool of crypto assets and receive a crypto-loan in return. In the case of MakerDAO, the platform leverages the Dai stablecoin as the underlying payment mechanism.

Concepts like CDP seem like a natural fit for security tokens but they require a stablecoin. In a CDP model applied to security tokens, an investor will register a group of crypto-securities as collateral and receive a stablecoin in return which can be used for any activity. If investors are interested on withdrawing their crypto-securities, they can simply send the stablecoin payment back to the CDP smart contract and the assets are released to the original wallet.

DS Backed Stablecoins

Today, most stablecoins are pegged to fiat vehicles such as the US dollar. However, we can envision other forms of stable or semi-stable coins that use a stable crypto-security underneath. One of my favorite examples is a stablecoin collateralized by US Treasury Bonds. In that scenario, the stablecoin leverages an underlying asset stable enough that can be used as unit of account while also have the benefits of a relatively stable dividend distribution. Granted, that model doesn’t quite fit the definition of a stablecoin but the concept is very intriguing nonetheless. One thing is for certain, as security token evolve, they can certainly provide the foundation of new forms of stablecoins that we haven’t envisioned before.

Atomic Swaps

I remain incredibly curious about the potential of decentralized transfers in security tokens. Among the different decentralized exchange mechanisms, atomic swaps between stablecoins and crypto-securities is one that I believe has a lot of potential in the near future. In that model, an investor will be able to exchange a pool of crypto-securities by directly “swapping it” by a position on a stablecoin held by another investor. This exchange will take place without any intermediary or broker. Given that compliance rules will be expressed at the token level, the potential for decentralized atomic swaps seems very feasible.

These are just some of the fascinating crypto vehicles that can be enabled by the relationship between stablecoins and security tokens. Stablecoins unlock the payment capabilities of digital securities providing the foundation for all sorts of new scenarios. At the same time, the evolution of security tokens can indirectly contribute to new forms of stablecoins that fall outside the traditional fiat pegged model.

About the Relationship Between Stablecoins and Security Tokens was originally published in Hacker Noon on Medium, where people are continuing the conversation by highlighting and responding to this story.